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number cruncher

What are we looking for?

U.S.-listed stocks with decreasing debt and solid cash flow.

The screen

As companies grow, they require influxes of capital to fund expansion. One of the most common sources of capital a company can utilize is debt. When used appropriately and within reason, debt can be an extremely useful source of funding for firms looking to grow, but when taken on in unmanageable quantities, can be an extreme risk to their continuance.

A few weeks ago, I wrote about Canadian stocks with low debt and high cash flow. In today’s Number Cruncher, I will repeat this process for the U.S. market.

The strategy ranks stocks based off of debt-to-equity (a liquidity measure, low values are preferred) and quarterly cash-flow momentum (measured as the growth in the most recent four quarters of cash flow relative to those same four quarters of cash flow lagged by one quarter, higher values preferred).

In order to qualify, stocks must have:

  • A debt-to-equity ratio less than 1.1 (to ensure companies are not overleveraged);
  • A cash-flow-to-debt ratio (trailing four quarters' cash flow relative to long-term debt) in the top one-third of peers – today this value is 0.27 or higher (figures for companies with no debt are shown as “n/c,” or not calculable);
  • One-year buyback yield (measures the amount of debt a company has repaid) greater than zero;
  • Annual cash-flow momentum (measured as the rate of change of annual operating cash flow per share) greater than zero.

More about Morningstar

Morningstar Research Inc. provides independent investment research in North America, Europe, Australia and Asia. Its research tool, Morningstar CPMS, provides quantitative North American equity research and portfolio analysis to institutional clients and financial advisers. CPMS data cover more than 95 per cent of the investable North American stock market. With more than 110 equity and credit analysts, Morningstar has one of the largest independent institutional equity research teams in the world.

What we found

I used Morningstar CPMS to back-test this strategy from November, 2001, to July, 2018. During this process, a maximum of 15 stocks were purchased. Stocks were sold if their debt-to-equity rose above 1.5 or if their annualized cash flow momentum declined below zero. When sold, the positions were replaced with the highest-ranked stock not already owned in the portfolio. Over this period, the strategy produced an annualized total return of 14.1 per cent while the S&P 500 Total Return Index returned 9 per cent across the same period.

Stocks that qualify for purchase into the strategy today are listed in the accompanying table. As always, investors are encouraged to conduct their own independent research before purchasing any of the investments listed here.

Emily Halverson-Duncan, CFA, is a director, CPMS sales at Morningstar Research Inc.

U.S.-listed equities with decreasing debt and strong cash flow

Rank Company Symbol Recent Price (US$) Mkt. Cap. (US$ Mil.) Div. Yield (%) Debt/Equity Qtly. CF Momentum (%) CF/Debt Debt Buyback Yield (%) Ann. CF Momentum (%)
1 ICU Medical Inc. ICUI-Q 272.15 5,570.2 0.0 0.0 48.4 n/c 0.1 172.6
2 Tableau Software Inc. DATA-N 110.86 9,195.1 0.0 0.0 45.5 n/c 0.6 4.4
3 Emergent Biosolutions EBS-N 64.89 3,245.8 0.0 0.0 38.8 16.02 0.4 54.6
4 Waddell & Reed Fin'l WDR-N 20.58 1,641.4 4.9 0.1 340.4 3.17 5.0 478.5
5 Hilltop Holdings Inc. HTH-N 20.09 1,900.0 1.4 0.1 102.3 0.76 2.6 226.1
6 BancorpSouth Bank BXS-N 33.85 3,340.7 2.0 0.0 23.7 6.95 3.6 17.7
7 MB Financial Inc. MBFI-Q 47.39 3,990.3 2.0 0.3 98.3 0.87 0.1 67.7
8 DowDuPont Inc. DWDP-N 68.82 158,793.7 2.2 0.3 38.8 0.41 1.7 54.9
9 Lam Research Corp. LRCX-Q 152.10 23,967.9 2.9 0.3 31.5 1.41 10.6 33.4
10 Fortinet Inc. FTNT-Q 88.17 14,912.8 0.0 0.0 19.5 n/c 2.9 32.2
11 Nutrien Ltd. NTR-N 57.84 35,824.1 2.8 0.3 32.3 0.34 3.5 19.4
12 Callaway Golf Co. ELY-N 23.00 2,172.1 0.2 0.0 19.9 19.19 1.0 70.2
13 Parsley Energy Inc. PE-N 27.75 8,790.6 0.0 0.4 31.5 0.49 0.1 81.5
14 La-Z-Boy Inc. LZB-N 32.00 1,492.4 1.5 0.0 14.5 644.53 3.5 12.0
15 Andeavor ANDV-N 155.59 23,513.7 1.5 0.6 28.6 0.27 0.9 67.9

Source: Morningstar Canada

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